Stumble It!Nov 19 2008
On Finances
Everyone is talking about TARP - the Troubled Asset Relief Program - colloquially called “the bailout” and it totals a staggering $700,000,000,000 of American taxpayer dollars. Taxpayers, investors, and Congress have all expressed outrage over the excess that has gotten the United States (and the World) into such a giant pickle. But it is not like we haven’t done something like this before, both in terms of scale and in terms of actual events.
All throughout the 1920’s, the boom times of American manufacture and finance, the general public was systematically “re-educated” by investment firms and banks to spend, spend, spend. Prior to this period of time, the American work ethic urged working and saving up money for when you retired; there was no Social Security, pension plan, or any safety net for when you got older, so whatever you saved, that’s what you lived on. Banks, though often the target of robberies by outlaw gangs, were seen as a place to put one’s money relatively safely and from which one could draw needed funds in times of emergency.
In the 1920’s, however, the advent of new technologies, the rise of outdoor mass marketing (also known as Billboards), and the extension of credit to consumers on a large scale. The American consumer was bombarded with images of new gadgets (electric vacuum cleaners, coffee percolators, and even motorized farm equipment) that were meant to usher in a new age of prosperity and enhance the quality of life for everyone. By and large, the products did do that, but the prices were such that meager savings was often not enough to cover the expenses of a new washing machine, refrigerator, car, radio, etc. and so credit was extended from banks, usually at fairly high interest rates. The same went for the stock market; investors bought “on margin” - essentially purchasing partial shares with credit extended to cover the rest. The logic was that the amount of money that was being made would far outweigh the interest rate beign paid. When the stock market inevitably crashed, the news was dire enough that investors began to panic; their once-golden profit game had come undone and now they were unable to pay back the loans they had taken out. Faced with defaulting loans, banks were themselves unable to pay off their debts - a situation made worse when post-crash market volatility made investors jumpy. People panicked and began to withdraw their money from banks, which dried up the banks’ liquid assets and accelerated their debt defaults; collapse was inevitable.
Fast forward 80 years. American consumers have long been bombarded with exhortations to buy, buy, buy. Buy bigger, buy more of the bigger things, buy even more than your neighbor who is trying to buy more than their neighbors. Credit card offers flew fast and free, with interest rates engineered to maximize profits. Automobile manufacturers offer more bells and whistles to outsell their competition - Hummvees offered the buyer enough torque to scale a 16″ vertical wall, as if that would ever be necessary - and prices rose commensurately. Real estate investment was seen as responsible and lending to homeowners was seen as a wise move since the mortgage was backed by insurance which bet against the success of the homeowner. “Flipping” properties became a national passtime as houses were purchased, rehabilitated, and resold in a short amount of time at hugely-increased prices.
Investment in the stock market through various opaque means became the way that all municipalities kept pace with rising costs without raising taxes on its citizens. (The following is a recapitulation of a story done on NPR a week ago). A small town was faced with rising costs of educating children at their local schools. A bond issue to raise property tax was out of the question but a Canadian bank based in the Cayman islands had a great alternative; invest in “Synthetic Securities Derivatives.”Synthetic derivatives, the bank argued, would allow the school board to earn a profit on its investment and to maximize their profit, they needed to take out a loan. The loan was granted through an Irish bank and for a while, the school board reaped the benefits of an agreement so complex, its printed version was over 3″ thick. The school board was profiting 1%to 2% on its loan. Then people began to default on their home loans. Investment bank Lehman Brothers was allowed the fail, suddenly the school board was not earning any money and was actually losing money on its investment. Washington Mutual defaulted…Bear Stearns…Linens N Things…all were covered in the insurance vehicle that the school board had invested in. The school board has to default on its loans to the Irish bank. The Irish bank, having gotten in over its head by loaning way too much money was besieged by defaulters which meant it could not meet its obligations either. Their credit rating sunk and that stain on its reputation affected the variable-rate municipal bonds issued by the City of Philadelphia. Cities are normally considered safe investments because they always pay the money on time - even after Katrina, New Orleans never missed a payment - but variable rate municipal bonds were offered at a certain rate only if backed by a bank with good credit (like the Irish bank). The credit rating of the Irish bank was so bad that investors were leery of investing in the City of Philadelphia’s bonds; the protection clause kicked in at which the bank agreed to purchase the bonds, but then again, so did the fine print. Instead of 20 or 30 years to pay back the bonds, Philadelphia now has 7. And the interest rate was increased as well. The City of Philadelphia uses bond money to maintain roads and bridges, pay police and fire departments, purify water and treat sewage, and a host of other activities that allow the city to operate. With the higher burden of repayment, the city may be forced to make hard, unappealing choices.
Of course, Americans aren’t the only ones who felt the pains of the boom-bubble-bust cycle; in the 17th century, the love of Dutch middle and upper classes for tulips caused the price of these rare and beautiful flowers to skyrocket. Speculation was rampant and so was theft, deception, extensions of credit, and complex financial arrangements all with the intent of reaping huge rewards on the simple, exotic flower. Prices were so high at one point that any artistic representations of the flower were enough to cause a buying spree. Paintings, flowers, stained glass, vases, and other items depicting the flowers were soon the most expensive items in Europe. Then the bubble burst. Teh result was economic collapse the likes of which Europe had never seen….all because of an Asian flower so far from home.
In 400 years, I wonder if the “flower” of American investment (toxic mortgages and synthetic derivatives) will seem as silly and inconsequential as tulips do now.
———————–Works Cited ————————–
National Public Radio: “A Tale of Intertwined Misery “
Galbraith, J. K. The Great Crash of 1929Houghton Mifflin Co. (1997)
Baker, L. E. “Public Sites versus Public Sights: The Progressive Response to Outdoor Advertising and the Commercialization of Public Space” in American Quarterly 59(4) December 2007
